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The author is Ishita Agarwal, a third year student at Symbiosis Law School, Pune.
Introduction
After a series of discussions and speculations, finally on November 9, 2021, the proposed changes in the Related Party Transaction (RPT) regime under the Securities Exchange Board of India (LODR) Regulations, 2015 were approved by SEBI. The genesis of these modifications is in the Working Group’s report on RPT. However, the report was materially altered by SEBI before the amendments were notified.
The amendments were brought into effect from April 1, 2022, which pushed India Inc. towards a new normal by making discernible alterations in the requirements related to RPT disclosure as well as approval applicable to the listed companies in the country.
Section 188 of the Companies Act, 2013, which defines arm’s length transactions, very well captures the primary reason behind developing the RPT framework. It highlights that in order to avoid any kind of “conflict of interest'', arm’s length transactions take place between two related parties as if they were unrelated.
Frauds that led to Amendments in the Regime
Promoters own or control a majority of the listed entities in India and with the alarming rise of abusive RPT cases wherein the listed companies diverted the resources to promoter groups, it became difficult for SEBI to curb such frauds. There is a long list of corporate frauds based on RPTs. Some of them are-
1. Satyam Scam
It is considered one of the biggest corporate frauds in the country. The scam was spotlighted when the Chairman of Satyam Computer Services Ltd., Mr. Ramalinga Raju, attempted to carry out a transaction with his related parties. Surprisingly, an announcement was made by him to acquire stakes in Maytas firms. These firms were headed by Ramalinga’s sons. However, this decision was withdrawn due to stark opposition by a lot of investors. Later, a ban for 8 years was imposed on the company by the World Bank. After a few days, a confession was made by Raju wherein he revealed the commission of fraud of nearly 7,000 crores. He also admitted that a large gap was created due to the commission of fraud over years and the sole intention to acquire a stake in Maytas was to fill in those gaps.
This entire episode had put forth the dire need to track as well as arrest the abusive use of RPTs.
2. DHFL Fraud
Dewan Housing Finance Company (DHFL) fraud is the first and the biggest bank fraud case which was primarily due to promoters being actively involved in funds siphoning and money laundering. Kapil Wadawan (CMD) and Dheeraj Wadhawan (Director) were booked for a ₹ 34, 615 crore cheating case. It was alleged that Rana Kapoor, the founder of Yes Bank, and the Wadhawans entered into a criminal conspiracy wherein DHFL was rendered financial assistance by Yes Bank in exchange for significant and undue benefits to him through the companies they held. Apart from this, related parties of the promoters were granted loans which played a major role in the commitment of this fraud.
Apart from this, renowned companies like Bhushan Steel, IL&FS, Jet Airways, etc have also abused the loopholes in the RPT regime to commit major corporate frauds. These series of alarming events led SEBI to speculate the then RPT framework and bring about stringent amendments to curb such frauds.
Key Amendments and their Analysis
Major modifications have been brought to the RPT regime by way of the sixth amendment to SEBI (LODR) in the year 2021. Some of the notable ones are-
1. Related Party- Definition
The definition of ‘related party’ has been significantly broadened by the amendment to encompass any entity or person belonging to the listed entity’s promoter group and any entity or person holding 20% or more equity shares either in a direct manner or as a beneficial interest under Section 89 (Companies Act, 2013). This will allow LODR to scrutinize all the promoter groups having significant control in the groups that are interlinked. Also, since the definition of ‘related party’ has been expanded to include individuals having 20% or more shares, all the significant shareholders and individuals commanding decision-making powers will now be covered by LODR.
2. ‘Related Party Transaction’- Definition
Only a transaction that was between a related party and an entity that was listed was incorporated in the definition prior to the amendment. Post the amendment, now it also encompasses any transaction between any entity that is listed or its subsidiary and the listed entity’s related parties or subsidiary of such party.
(a) Cross RPTs
Now, since the category of transactions added to the definition of RPTs has expanded its ambit, the bar or the threshold of 1000 crores or 10% of the listed entity’s annual consolidated turnover to seek the approval of the shareholder will be achieved sooner than the time it usually took. A subsidiary company, as per Section 2(87) of the Companies Act of 2013, also incorporates any foreign-based subsidiary. So, if a foreign-based subsidiary transacts with another company, the success of that transaction will be in the hands of the Audit Committee as well as the parent India-based company’s shareholders. This will lead to issues regarding jurisdiction and conflict of laws.
Ambiguity would arise concerning the implementation procedure since the foreign subsidiaries would now be regulated by the laws prevalent at their incorporation place. Apart from this, the ‘separate legal existence’ principle can also be a ground to impugn the amendment. Certain exemptions can be granted and detailed guidelines can be rolled out specifically with regard to foreign subsidiaries as possible solutions to these hassles.
(b) ‘Purpose and effect’ Test
There is another important aspect of the recent amendment which is due to come into effect from April 1, 2023. It is regarding a transaction that has been entered into between a listed party or its subsidiary and any party that is unrelated, with a “purpose and effect” of benefitting the related party. This has been borrowed from Premium Listing Rules of the UK but no guidelines regarding its implementation have been laid down yet. Although, the use of the word ‘and’ in ‘purpose and effect’ reflects that both the terms have to be read together while applying this test. Also, if a transaction is entered into without any intention to benefit a related party, an indirect benefit to such a related party will not make the transaction an RPT.
This provision will aid in the prevention of fraudulent transactions. Also, the companies will not be able to circumvent the approval procedures by transacting with an unrelated party. However, the application of this test will be an uphill battle for the audit committee as well as the compliance officers as it would require them to virtually dig into every commercial transaction to make sure that the ‘purpose and effect’ of these transactions is not to benefit a listed entity’s related party or any of its subsidiaries. This can make the regulations practically unsound for large listed entities.
(c) Exclusions included in the definition
Before the 2021 amendment, separate RPT policies were formed by the companies and certain exclusions, in line with the Act and the LODR, were made. However, certain exclusions have been introduced in the definition of RPT itself by the amendment. Corporate actions such as buyback, preferential allotment, etc., receipt of deposits by NBFCs and banks, and preferential system for issuance of specific securities, etc are some of the exclusions that have been incorporated. Now, only the set of exclusions that have been incorporated by this amendment will have to be followed by the companies and no further exclusions can be made by the companies at their disposal.
Conclusion
The RPT framework had a lot of loopholes that were being repeatedly exploited thereby putting the interest of the stakeholders in peril. Therefore, to curb the abusive use of RPTs, certain amendments were rolled out by SEBI (LODR) Regulations 2021. It has brought about some well-thought modifications in order to curb fraudulent transactions. However, certain aspects like the ‘purpose and effect’ test are ambiguous and further guidelines and notifications are required to bring about some lucidity. Apart from this, some modifications like bringing the transactions of even the foreign subsidiaries under the umbrella of scrutiny have gravely affected the separate legal entity principle and have restricted their autonomous decision-making power.
Although safeguarding the interest of the minority and moving ahead towards better corporate governance were the primary objectives behind the modifications brought in the RPT regime, it has burdened the companies with heavy compliances. Also, companies might end up in a perplexing situation due to a lack of clarity regarding certain modifications which can lead to an unintentional breach. Therefore, to safeguard and balance the interest of the parties involved, SEBI must address the concerns and ambiguities associated with the amended regulations.
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